How to Speak Money — Book Summary

What the Money People Say – and What It Really Means

how to speak money book cover

How to Speak Money Teaches The Language of Money

How to Speak Money teaches the readers on the essential language is a tool of communication in all areas of life. The practitioners in various professions generally use their inside language for the sake of accuracy and efficiency. For instance, most people do not need or want to know why a plumber chooses one tool over another to fix a leaky faucet. But people can also use jargon, or specialized terms, intentionally to exclude outsiders from conversations.

Sometimes experts in certain industries want to protect their status by using their own lingo — hence they speak money. But words and phrases also can entrench a particular worldview. For instance, they can organize society according to economic beliefs, such as wealth trickles down. Trusting in experts makes life easier for most people, until disaster strikes.

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If a widespread sewer failure occurred, everyone would need to learn plumbing terms. The 2008 financial crisis rained calamity on the general public. Now, those who learn the language of money can help protect themselves in the future by participating in dialogues and forming their own opinions. People need greater knowledge about the economy and the financial system to make informed decisions and better choices about managing their money.

“Economics is about tools. And the most important of these tools, the one without which the others won’t work, is language.”

The world of economics, business and money have developed its own vocabulary – words with particular meanings, special terms for complex concepts, and idioms or figures of speech.

Proficiency with a particular language, like the language of wine, necessarily excludes people who can’t detect the distinctions that are clear to insiders. But people can learn specialized languages when they participate in related experiences with expert guides or teachers. In most cases, the language in a field permits participants to share in informed discussions without value judgments, even when they disagree on interpretations.

At the same time, you need knowledge and the words to express and convey it to give validity to your value judgments. Although most vocabulary in the world of money is value-neutral, the terminology arguably can help lead people astray in some areas.

Economics began as a branch of moral philosophy. But as it developed as a discipline, it has sought to follow the hard sciences, such as physics, into the realm of mathematical absolutes and scientific laws. In some cases, however, institutionalized thinking by economists who share a certainty, even if unrealistic, about their mechanistic assumptions has led to potentially dangerous, out-of-touch perceptions of how markets and societies must function. Hence, the ability to speak money is important for us to actually grasp what they mean.

Those views are moral judgments.

Even so, economist Anatole Kaletsky wrote on April 4, 2013, in The London Times, “all the main questions in economics remain open.” That is still true. The conversation is ongoing, but to join in, you need to understand the language, you need to be able to speak money.

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These keywords and phrases should give you a start:

Efficient Markets

Begin with the neoliberal political philosophy that says all public good is a by-product of making the individual paramount as a moral entity. This code of ethics took hold in the 1980s with Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States, and it has become the basis of organizing societies and economies for the benefit of individuals.

On a practical level, it has led to policies that affect income inequality, free trade, unions, the privatization of government services, deregulation, public spending, support for “wealth creators” – on the assumption that wealth trickles down to other participants in the economy – and the overriding dogma that markets are “always right” and can “self-regulate in all conditions.”

“As your vocabulary becomes more specific, more useful, more effective, it also becomes more exclusive. You are talking to a smaller audience.”

The efficient-market theory comes from the belief that markets self-regulate. This theory, which dominated policymakers’ mindset during the period leading up to the 2008 financial crisis, assumes that when people buy or sell assets in the market, the prices of those assets correctly incorporate all the information available about their potential risks and rewards. That would mean that outperforming the market is impossible.

This theory explains the investment strategy of arbitrage, the process of traders trying to profit from tiny price differentials during the time before prices eventually equalize. This theory also implies that prices have no memory, which means that price movements one day have no bearing on price movements the next day. Taken to its logical conclusions, the belief in efficient markets downplays the possibility that assets can experience bubbles or speculative manias.

It comes down to theology which believes that because prices are always rational, bubbles can’t exist. However, the success of momentum trading, which acts on the reality that price movements in one direction or another carry forward from one day to the next, contradicts this belief.

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How to Speak Money — The Language of the Boom and the Bust

Securitization

The widespread use of securitization in the financial sector was an important feature of the boom before the crisis. Securitization entails creating a financial instrument that you can trade quickly and that takes its value from other financial assets that you can’t sell easily in their original form. That’s an important vocab to speak money.

A major component of the financial crisis was the massive transformation of mortgage debt from traditional mortgages (held by local banks in the usual way) into securitized assets, representing claims over amassed quantities of mortgage debt. The repayments from the customers’ mortgages provided investors with profit for holding the new asset. But the main danger of this securitization is that it reduces the mortgage originator’s motivation to make safe loans in favour of passing that mortgage debt quickly along to other institutions.

“Your ‘asylum seeker’ is my ‘refugee,’ your ‘entitlements’ are my ‘pensions’.”

The basic premise of banking – that you lend money only to people who can pay it back” – disappears in securitization. The difficult nature of the way institutions used securitization led to an uncontrollable dispersal and magnification of the risks of the housing bubble. The risks were destabilizing because they were harder to assess when the crisis hit.

“The language of money is complicated because the underlying realities are complicated.”

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Derivatives

The basic nature of derivatives added complexity to the innovations in securitized financial assets before the crisis. The values of other assets contribute to the price of a derivative product, but the actual financial instruments are not solidly connected to those underlying assets.

Thus, two parties can create a derivative trade if both agree to a contract based on, but not connected to, the price of a real underlying asset. Thus, the derivatives’ market volume can rise well above the market volume of the assets that underlie the derivatives’ values. This happened with securitized mortgage assets; the huge volume amplified and complicated the risk when the bubble burst.

Derivatives are useful for many genuine reasons, such as the classic case of farmers reducing their uncertainty ahead of harvest by locking in future crop prices. In any case, some trader on the other side of that contract has to be willing to take the gamble. However, the enormous size of modern derivative markets suggests that speculation is more in play than any type of conservative business risk management.

“Baked into this neoliberal model is a set of assumptions that embody what Marshall saw as the economist’s mistaken belief in ‘constant and mechanical actions’.”

Credit default swap

The credit default swap is infamous for its role in the 2008 crisis. This instrument allows an organization to charge a fee for guaranteeing that a third party will successfully repay a loan. The surprising aspect is that an enterprise can enter into this contract even if it isn’t the organization that made the loan. That’s less like insurance and more like a form of gambling.

The layered structure of such financial instruments along with the boom and bust in real assets made the boom more profitable and the bust more severe.

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Hot money

Consider also hot money, which is cash that moves around the globe looking for the latest quick return. Hot money rose from 60% of global gross domestic product (GDP) to more than 450% from the 1990s to the first decade of the 2000s. Combining the uncontrollable risk of securitized derivatives with hot money portends an increase in the potential for booms and busts.

“The link between neoliberalism, efficient-market theory and bubbles was one of the reasons for the disaster of 2008.”

The 2008 crisis is sometimes referred to as a credit crunch because it brought about a contraction in lending. As the housing market started to turn downward it exposed the weaknesses in the financial system.

Deleveraging

Deleveraging which is reducing the ratio of debt to income or assets and a pullback on extending new credit both took place abruptly on a massive scale. Deleveraging is often a sensible course for an individual or a business. However, recessions occur when everyone deleverages at the same time.

The Language of the Era After the Crisis

Equity ratio

After the 2008 debacle, questions arose about the role of the big banks in the financial system and their leverage practices. Regulators measure the leverage of banks by calculating how much their loans exceed the value of their capital and then converting the results to an equity ratio.

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Core capital

Major global banks run at surprisingly low equity ratios and thus maintain slim margins of safety. In the early 2000s, many banks operated below the 3% mandated by Basel III, an industry standard. Therefore, some banks prefer to use a core capital measure, which adds some types of profits and debt on the equity side and makes them look safer. Core capital is an issue of debate.

Shareholders of large banks have limited liability, that is, they can lose only the value of their shares but no more. Some advocates who are concerned about bank equity are now calling for different ownership structures for risk-taking investment banks. They want to make the owners further liable for downside risks.

This line of attack reflects the financial world’s moral hazard problem, in which shareholders and employees reap limitless rewards from the upside but don’t risk anything except their shares or, perhaps, their jobs when a bubble bursts.

In the 2008 crisis, government bailouts covered serious bank losses by putting the cost at the door of the taxpayer.

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Other Terms to Know

Shadow banks

Shadow banks make up a growing sector of the financial system. These banks are a diverse set of institutions and markets that, collectively, carry out traditional banking functions – but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions.

Shadow banking, which includes mortgage lenders, significantly contributed to the credit crunch. In 2012, the Bank of England estimated the size of this sector at $67 trillion, equal to global GDP. The industry is a serious concern in the ongoing conversations on financial policy.

Bitcoins

Bitcoins are digital money, created by computer algorithms and used mainly “in buying and selling things anonymously” online. Bitcoins are basically an electronic balance sheet ledger that is transparent and anonymous. Arbitrary acts of trust underpin a bitcoin’s value, which can fluctuate wildly. In early 2014, its price moved from $1,200 to $50 in a few months. However, interest in bitcoins is significant across the world of finance.

“When the financially literate talk about interest rates, they are bringing to bear a whole set of linked ideas.”

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Quantitative easing (QE)

Quantitative easing (QE) was the main plank of the governmental response to the crisis. The way QE works are that a government buys back some of its bonds – money it previously borrowed from investors. This policy was an attempt to provide economies with a shot in the arm when it was no longer possible to reduce interest rates to stimulate economic activity.

The main point of contention surrounding QE is that the government buys back its bonds with money it creates out of thin air. In normal times, creating money is taboo, because it risks inflation. Some central banks, including the US Federal Reserve, introduced a policy of “forward guidance” in an attempt to bring further confidence to the economy. These institutions aimed to make their interest rate and QE policies more predictable and smoother for the benefit of fragile financial markets. QE, bailouts, insufficient taxes and increased spending all worsen annual deficits – the end-of-year shortfalls in national accounts – and add to total government debt.

“Money is a lot like babies, and once you know the language, the rule is the same as that put forward by Doctor Spock: ‘Trust yourself, you know more than you think you do’.”

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Interest rate

Interest rate is the most important vocabulary term, and everyone should know it. Understanding interest rates is critical to forming opinions about government policies on matters such as trade treaties, inflation and employment, as well as being necessary to manage your personal finances in areas like deposit accounts, mortgages and investments. “The interest rate is the cost of money at any given moment.” It is also a measure of the amount of your risk-free investment return. Some consequences of high-interest rates include a greater volume of mortgage defaults, lower amounts of home equity from falling prices and reduced business investment. Elevated interest rates also lead to higher manufactured goods costs, and thus a decrease in exports and a “hollowing out” of industries, as companies outsource manufacturing and other functions or move them online. That’s arguably the most important vocab to speak money.

You might be interested in TED ted related to money: On “money shame” and “an honest look at the personal finance crisis“.

Read How to speak money

READ MY OTHER BOOK SUMMARY AND REVIEW

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Author: Muhamad Aarif

A notorious book addict by night and an oil and gas executive by day. As Mark Twain said, "The man who doesn't read good books has no advantage over the man who can't read them." So, read, read, and read some more.

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